When Loyalty Programs Are A Waste Of Money

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BY Expert Blogger Don Peppers | 03-02-2012 | 1:25 PM

This blog is written by a member of our expert blogging community and expresses that expert's views alone.

In times like these, cost cutting and streamlining are compelling business strategies. Business executives sometimes have second thoughts about their loyalty programs and ask our consultants whether it’s really worth the cost.

The answer, however, depends on how well the program is aligned with the type of customer base being served.

A loyalty program, or frequent-buyer program, rewards customers with points, miles, or other credits that can be redeemed for discounts and free products. Loyalty programs have become ubiquitous in a variety of industries, from airlines and groceries to credit cards, packaged goods, mobile phone carriers, coffee and restaurant chains, and retailers of all kinds. But they are probably over-used; last year in the U.S. alone, researchers tallied more than 2 billion loyalty program memberships, which means the average U.S. household belongs to about 18 different loyalty programs.

Loyalty programs do cost money, not just in terms of the rewards themselves but also the administrative burden, so it’s not uncommon for executives to question their decision to implement one. Evaluating a program, however, should be based on two issues: First, under what circumstances will a loyalty program generate incremental repeat business? And second, how valuable are its other benefits, including the chance to gain insight into individual customer needs and preferences?

In 1996, Martha Rogers and I published our second book together, Enterprise One to One, and we tackled the first question head on. We concluded that a loyalty program can directly increase customer loyalty when a business’s customer base had two characteristics:
1. Just a few high-value customers do the vast majority of business; and
2. Customers’ needs are fairly uniform, meaning there isn’t much product differentiation in the category.

(Recently my Twitter buddy Arie Goldshlager alerted me to the fact that in 2011 two Yale marketing professors, K. Sudhir and Jiwoong Shin, were given the John D. C. Little Award in marketing science for having proved Martha’s and my argument mathematically.)

The long and the short of it is that paying customers for their loyalty is more likely to generate a direct profit when your customers have similar needs but highly different values. The airline industry is a great example. At an airline, the top 1% or so of flyers generate a substantial majority of the profits, and yet customers are fairly uniform in terms of what they actually need. Aside from seat or meal preferences, customers all want the same basic thing--to get safely and reliably from Point A to Point B--and pretty much any airline that flies a route can do the trick.

So airlines can profit by purchasing customer loyalty directly, but if your business is not characterized by a similar kind of customer base, with a small minority of extremely high-value consumers who have relatively undifferentiated needs, then it might not make as much sense for you.

Which brings us to the second issue: What are the other business benefits a loyalty program can generate? The real secret to the vast majority of loyalty programs has to do with compiling and using customer-specific data. By encouraging customers to identify themselves (in order to get their benefits) you can track their purchases and interactions, and then use insights from this data to tailor your offer, your product or your service to individual tastes. In effect, rather than rewarding customers for their patronage, you’re rewarding them for identifying themselves.

This strategy, however, will be more compelling when you don’t already have a natural mechanism for linking customers’ purchases to their identities, and when your customers are highly diverse in their needs. Grocery retailing is a good example here. There are about 40,000 different products on the shelves of a typical U.S. supermarket, but the average household will stock less than 1% of them, and every shopper buys a different assortment, with different brand preferences, types, and sizes. Moreover, unless shoppers somehow identify themselves at the cash register, the grocer has no practical way to keep a record of any individual shopper’s purchases. By using a loyalty program to identify individual customers and track each customer’s transactions, however, a grocer can compile enough data to make personally relevant offers.

Tesco is a U.K.-based grocery retailer that does exactly that, for instance. One of the world’s most sophisticated users of customer data, Tesco launched its Clubcard loyalty program in 1995, and it now sends a quarterly newsletter to 16 million U.K. Clubcard members in 9 million different versions! Every Clubcard member gets a highly customized set of discounts and offers, and the company claims a response rate on the newsletter of some 25%. Analysts have estimated that the program could be generating more than £100 million in incremental revenue for the company every year.

In recent years, Tesco has been expanding beyond the U.K. with a number of innovative offerings in different countries, and I think if there’s one business model that might eventually give WalMart a run for its money in the U.S., it would be Tesco’s. WalMart offers “everyday low prices” to every shopper, but some day Tesco could offer “personalized lower prices,” based on each individual shopper’s own needs.

So if you want to avoid wasting money on your company’s loyalty program, ask yourself a few basic questions:

• How much of your business comes from the top 1% or 2% of your customers?
• Is it possible to identify and track your customers’ individual purchases even without a loyalty program?
• Do your customers have diverse needs and preferences? and
• Are you prepared, organizationally, to treat different customers differently?